Bank Shot

In Basketball the most denigrated shot (other than the highly effective but defunct underhanded free throw) is the bank shot.

Although the science of the bank shot argues for a higher success rate than a swish, it is used only in desperation when all other options are gone. 'Real' pros don't use the shot willingly, as they know that the nightly highlight reel rarely shows such a pedestrian play. Sportdesk loves showing an ankle-breaking step-back three or monster windmill dunk anytime. For players, getting your bench guys to over-react is a strong motivator. A bank shot just produces a yawn.

Investors are now faced with just such a conundrum. All the easy money is gone after the 'Powell Put' has dragged investors, kicking and screaming, back to the market. Bonds have rallied hard. Utes and Reits are at all-time highs. Staples, Big Tech and Real Estate are now priced for perfection. Are Banks the only 'shot' left for market pros?

Earnings from the money center banks are now rolling in and, so far, the market seems unimpressed. The margin compression caused by the flattening yield curve is evident in the weak numbers. Add to that, declining trading revenues, and the trailing earnings are flattish for the big banks. But investors are missing the point here.

So what does it take to motivate this forgotten group to lead the markets in the next leg higher? The past provides some clues.

In 1995, the Fed was in danger of over-tightening, as they responded to an uptick in inflation. Fighting the last war is always a behavioral trait of group-thinking policymakers.

But Greenspan fooled everyone by reversing course and actually cutting rates in mid-1995. The curve stopped flattening and went sideways. The market responded accordingly to the soft landing cue and we see the results below. The double barreled effect of an improvement in net interest margins and reduce loan loss potential implied by a simple flattening in the yield curve was a powerful driver of bank outperformance (second graph).

10 Yr Treasuries - 2 Yr Treasuries, 1993-96

Bank of America vs SPY, 1993-96

The yield curve stabilization created a catch-up trade in the perennially vilified banking sector, as the value case won out over overblown recession fears. The Fed bought time for the cycle to play out even longer that investors had thought, leading to a rush for cheap stocks that benefitted from slightly rising bond yields.

This past month has seen just such a stabilization in yields, as shown below. The importance of this cannot be underestimated. A reversal from the razor-blade bannister that characterized last year's yield curve plunge is the most important fundamental change in two years. I listen when the market speaks. While recession fears are still present, now a soft landing scenario cannot be ruled out given the definitive change in the yield curve's shape shown below.

10 Year Treasuries - 2 Yr Treasuries, 2017-19

Given recent communications, it is obvious the Fed has stopped driving in the rearview mirror of domestic data and moved to a more reasoned, holistic view of global markets.This is a necessary prerequisite for a 1996 repeat. It will be confirmed by a rate relief this month, given that Powell virtually promised a cut in his testimony to Congress last week.

Investors have responded to the "don't fight the Fed" mantra and have dutifully fallen in line. Hedgies have abruptly given up any hope for a repeat of the December debacle that drove their bearishness to underperformance extremes. A complete reversal of their below-normal commitment to equities is now in full swing.

Hedge Fund Exposure to Equities

Likewise, AAII investors have shed their bearishness as shown by a drop in the reading in those expecting a lower market to a below average 27.5%.

So don't worry, be happy. Any type of shot, bank or otherwise should count here if the longest economic cycle in history is prolonged by central bank action. Banks are the softest of soft cyclicals,(aka chicken cyclicals) for most investors. With yields that are quite juicy, and with stable consumer lending franchises pumping out predictable profits, other worries can be put aside as long as the yield curve co-operates.

Deeper cyclicals, such as metals and cap-ex industrials are the low percentage swish shots that make headlines. I'd rather take a higher percentage 'Bank' shot right now. Buy JPM!

Risk Model: 3/5 - Risk On

Only by a hair's breadth is the AAII bull/bear component in negative mode, but the model is the model. I suspect this week, with a comforting tone out of the Fed and 'as-expected' earnings (the bar has been set low enough), the average investor will start to buy into the market and the Bull/Bear ratio will kick the model into a 4/5 reading. That is the highest return mode for the model, given the backtesting that Adam Bomers produced when we worked at Aurion Capital.

This market is now a hard tape to fight, especially if the banks kick in. Mea Culpa on my previously bearish stance for now.

Next to fall in line is the deeply depressed Copper/Gold ratio. Should we get the bank rally I'm hoping for, this indicator should be next. Any slight progress on a trade deal will help. Chinese data this week has shown signs of stability, but the jaded market is skeptical still. Watch the for the possibility of a triple bottom in Copper here to confirm the soft landing scenario.